Paying more upfront to save money in the future is a common phenomenon when it comes to consumer goods, but we don’t often associate that practice with financing. For example, you might pay $400 today for a vacuum that will last you 20 years rather than $150 for one that you’d need to replace every five years. This, in essence, is the crux of paying points: will it reduce your long-term costs meaningfully, helping you advance your long-term financial plan? Before we give you some tools to answer that question, let’s review key definitions.
Mortgage discount points enable the reduction of your interest rate through payment of fees to the lender. For this reason, points are sometimes referred to as “buying down the rate.” By reducing your interest rate, you also reduce your monthly payment. One point is equal to one percent of your loan amount, so one point for a $360,000 loan would cost $3,600. Paying more upfront reduces your long-term costs, but like any financial decision, whether it’s the right move for you depends on your financial goals.
It’s important to note that the degree to which mortgage discount points reduce your interest rate depends on several factors, including your lender, the loan program you choose, and the mortgage market.
1. When will I break even?
Say you refinance into a new 30-year fixed-rate conventional mortgage for $360,000, the remaining balance of your loan. Your proposed interest rate is 3.5% with no points, and your monthly payment is $1616.56 (3.53% APR based on 80% LTV). Then, let’s suppose you pay two points (2%) on your loan, or $7,200, which decreases your interest rate to 3% (3.19% APR based on 80% LTV). Your new payment is $1517.77, and you are now saving $98.79 per month.
To figure out when you will break-even from the cost of discount points, you can simply divide the expense of the points by the monthly savings amount ($7,200 / $98.79). The result is 72.9 months or a little over six years. Which brings us to our next question…
2. How long will I remain in the mortgage?
In our example, if you were to remain in your mortgage for six more years, then paying points could be worth it. So, if you are in the 10th year of your mortgage and intend to move within the next five years, points would not be worth it. Statistically speaking, this is likely, as most homeowners remain in their properties for an average of 13 years. On the other hand, if your mortgage is relatively new, say, four years old, then paying points may make sense.
3. What is my financial position and the rate environment?
When homeowners refinance, closing costs are sometimes financed into the new loan. If you are refinancing and have sufficient equity in your home to pay higher closing costs, you can pay mortgage points. Those costs can be rolled into the loan to lower your monthly payment without out-of-pocket payment.
In a low-rate environment, paying points will decrease the chance you may want to refinance in the future. Since you pay closing costs whenever you refinance, paying points to get the best rate possible may make sense. By contrast, when rates are high, you may consider waiting until they drop in the future and refinance then as opposed to paying points when you take out your mortgage.
If you have additional funds in the bank and can afford it, paying points on your mortgage refinance in a low rate environment can be a worthwhile investment – provided you intend to stay in your home for a period of time that goes beyond your break-even point. On the other hand, if you aren’t financially positioned to make additional upfront payments at closing for your new mortgage, you may consider keeping your quoted interest rate and refinancing at a later date. Need some help crunching the numbers? Contact us to connect you with an Apex mortgage banker.